SDIRA w Checkbook Control & Prohibited Transactions

5 Replies

I know there are a number of threads on this topic, but none that I've found addressed my specific question / dilemma. 

I already have an established SDIRA, and have done a few investments through my current Custodian via their normal compliance review, and subsequent funding process on a deal-by-deal basis. I am now trying to establish a Single Member, Manager Managed LLC of which my SDIRA will be the sole member, and I will individually be the Manager. That will then become the only investment at the Custodian level, and all individual transactions will be owned by the LLC. Like many of you that have done this already, my objective is simply to have checkbook control and be able to move quickly when deals come along.

My current custodian is supportive of this model, however they said that if I register the LLC myself, that would be considered a prohibited transaction. Curiously though, they said I was free to use personal funds to pay an attorney to register the LLC for me, which seems to be MORE of a violation of the spirit of the rules than would be the act of registering an LLC. When I pressed them and asked for a link to a tax court pronouncement, or other IRS guidance on that, I was simply told "The IRS is quirky sometimes on how it decides things". That was not a satisfactory answer, and I'm skeptical that they even know what the IRS has "decided" on this topic, so I'm looking to others here that may have encountered this before.

I have exhaustively read IRC 4975 and related docs (even the IRS guidelines for auditors examining prohibited transaction violations), and I can't find anything to support what I was told by my custodian. Further, when I told them I was comfortable with my own analysis of the reg and that I would defend my decision to the IRS if ever required, they essentially said "OK, but our Compliance department may not approve the structure unless an attorney registered the LLC", which I find to be absurd. There is no legal basis for that requirement.

Anyone encounter this before, or have thoughts on this?

Thanks,
David

@David Fitch

This is not a do-it-yourself adventure.  Please reach out to an attorney that specializes in the setup of such entities and is familiar with the intricacies of the tax code.

While some custodians are supportive of this service, they really want nothing to do with the formation or support of an IRA owned LLC for a variety of reasons, namely that it is a less profitable service for them. They may refer an attorney who can produce compliant LLC documents, but generally that is all you will receive. This type of structure necessitates a pretty solid integration between the provider of the legal platform and the custodian, not a one-time hand-off.

We probably get about 10 inquiries a month from folks who have cobbled together a LLC in the fashion you describe, have no access to meaningful support as a result, and are lost and frustrated. In many cases including two I can recall from this week, they have engaged in a prohibited transaction through lack of proper guidance.

Lastly, there are alternatives to an LLC that can provide checkbook control and will not subject you to $800 per year in California franchise tax costs. You'll want to explore that concept by speaking with a specialist.

With respect to your specific question, the issue is not of payment, but of services. You can pay for services surrounding the administration of an IRA either personally or from the IRA. For you to put the time and energy into creating the LLC is considered to be providing services to the IRA, which is prohibited. While a LLC filing is pretty trivial and may not really cross that line, the custodian you refer to is likely taking a very conservative position, which is right for them to do.

All transactions must happen within the account itself so no you cannot pay it personally. Always take the conservative position with regard to such transactions.

Thanks Brian; I appreciate any and all input. 

To be clear, I may be a bit more sophisticated than the ~10 folks per month that you referenced. I run syndicated REI deals, each with a multi-LLC structure, requisite SEC filings, state filings where investors reside, etc. I use attorney's for most of that, including developing the Operating Agreements, and handling the filings, but I register the LLCs myself. I could certainly engage them in this scenario if justified. However, I'm the arbiter of when an expense is justified because I'm the one writing the checks. I reject the assumption that an attorney is required for any and all activities that have a whiff of complexity. I deal with similar complexity every day. I also read contracts, and interpret regs constantly, so I'm perfectly willing to debate and defend a position that isn't contradicted by black and white language, with an IRS Auditor or anyone else.

Your point about it becoming less profitable to them is valid, but irrelevant in the scenario I described. As I said, my custodian already allows it, and they aren't suggesting that I use an attorney that results in them receiving any additional $$. 

Your last point is the one that differs from reading that I've done; which is to say, I understand that I CAN pay for services in support of my IRA out of my IRA (including formation of an LLC), but NOT with personal funds (which you're saying is acceptable). I don't see anything written by the IRS that allows the latter, but not the former. Or, perhaps you're saying it is allowable to pay for activities considered to be "administration" of the IRA with personal funds, but not for services that support investments held by the IRA? That is a distinction I could understand, but then I'd be on the hunt for where that is spelled out by the IRS, tax court, or other pronouncement.

In any event, I appreciate you reading my post and responding. 

David

  

Brian -

I looked at your site; I'll submit a request for a consultation. I am open to the idea that I should have more support specific to this topic.

Thanks

David

@David Fitch I agree with you that you can probably set up the LLC yourself - I can't imagine that it constitutes a prohibited transaction. It sound like you're comfortable with the law, but it's not just the law that governs. I'd press the custodian a bit for better answers and some law/memorandum/opinion and field guidance citations. I have found that the first line folks have marginal depth of knowledge and/or are prohibited from straying from the canned responses due to liability exposure. Escalating the question(s) to upper levels has been necessary when I was pressing the envelope and wanted to understand the underlying governance - as it appears you do. In those cases, I have found management very informed and very helpful.

That said, I used an atty set up the SDIRA/SMLLC (FYI - SDIRA/MMLLC also has its uses & I see that you have some familiarity with those). The language contained in my SDIRA/LLC Operating Agreement is both general as to LLC operations and business/investment activities anticipated, and also specific as to ERISA compliance. There are also some pieces of language that have to be there in order to give you future funding flexibility (and probably other pieces too), which you might overlook if you do it yourself.

I agree with @Brian Eastman , IMHO, the stakes are too high to to get this wrong, so I bit the bullet and had a pro set the LLC up for me. I think I paid about $900 several years ago and got the state and fed pieces. I also use that firm for counsel when I have questions about the propriety of gray area actions I am about to take or have taken.

I see that you have questioned the position stated by @Steven Hamilton II . I also wondered about that piece when I was setting things in motion. I was advised by the firm that set up my SDIRA/LLC that I could pay those fees out of pocket personally and did so. Get you own advice on that.

I admire your accomplishments and apparent acumen in business and understanding of law. I also agree with your assertion that a "whiff of complexity" does not automatically require engaging a lawyer. I would humbly remind... even lawyers hire lawyers when the stakes warrant - sometimes only as a sounding board or to assure that they have not missed something. In my mind, the potential for blowing up my IRA warranted hiring an expert. We all have different thresholds.

Best of luck!

Keith